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In May, Williams-Sonoma Inc. (NYSE: WSM) posted strong first quarter earnings results and reiterated their fiscal year 2023 and long-term guidance. Despite challenging macroeconomic conditions, Williams Sonoma still posted a solid FY23 1st quarter earnings result. Comparable brand revenue declined 6%, with a 2-year growth comp of 3.5% and a 4-yr growth comp of 46.5%, showing the brand’s substantial revenue growth over the last few years. Williams Sonoma also delivered GAAP diluted EPS of $2.35 a share, with strong gross margins of 38.5%, and recorded a strong liquidity position with nearly $300 million dollars of cash at the end of the quarter with no borrowings outstanding and $343 million dollars in operating cash flow. In terms of guidance, management expects the business to grow net revenue between -3% and 3% with an operating margin between 14% to 15% in fiscal year 2023. Long term, management expects mid-to-high single digit annual net revenue growth with operating margins above 15%. With these strong financial figures in mind, we believe that Williams Sonoma is an interesting investment trading at an attractive valuation.
Williams-Sonoma Inc. (NYSE: WSM), founded in 1956 by Chuck Williams in Sonoma, California, is the world’s largest digital-first, design-led and sustainable home retailer. The business’ products represent distinct merchandise strategies (brands include Williams Sonoma, Pottery Barn, Pottery Barn Kids, Pottery Barn Teen, West Elm, Williams Sonoma House, Rejuvenation, and Mark and Graham) and are marketed through direct-mail catalogs, retail stores, and e-commerce websites. The business operates in the United States, Puerto Rico, Canada, Australia, and the United Kingdom, offering international shipping to customers worldwide. Pottery Barn makes up 41% of Williams Sonoma’s total revenue, with West Elm making up 26% of total revenue, Williams Sonoma making up 15% of revenue, and the rest of the brands making up 18% of revenue combined, creating a diverse revenue stream.
The specialty e-commerce and retail businesses, in which Williams Sonoma operates in, are highly competitive and subject to seasonality. Williams Sonoma’s websites, direct-mail catalogs, and retail stores compete with other e-commerce retailers, discount retailers, other specialty retailers offering home-centered product offerings, and large department stores. Management acknowledges that the shift to e-commerce lowers barriers of entry and even encourages the entrance of new competitors. The business competes on the basis of strong brand name recognition, merchandise quality, strong customer service, the location and appearance of their physical store locations, e-commerce and marketing capabilities, their proprietary customer list, and in-house design. In addition to this competitive landscape, Williams Sonoma can also fall victim to seasonality, along with their competitors. Historically, a significant portion of the business’ net earnings and net revenues have come during the period October – January, with net revenues and net earnings usually being lower during the period February – September. While seasonality can be a red flag for an investor, it should be noted that this general pattern is common within the retail industry.
Management is solid and their capital allocation priorities align well with shareholder interests. Management rewards shareholders with share repurchases and dividends. During fiscal year 2022, management repurchased 6,423,643 shares at an average cost of $137 dollars per share at a total cost of $880 million dollars. These repurchases were done under the $1.5 billion dollar share repurchase program, approved in March of 2022. As of the end of January, this program still had $690 million dollars remaining for share repurchases. In March, the Board of Directors authorized a new $1 billion dollar share repurchase program, replacing the existing one. In addition to the 2022 share repurchases, management repurchased 5,102,624 shares at an average cost of $176.27 dollars per share at a total cost of $899.4 million dollars in 2021. In 2020, management repurchased 1,496,100 shares at an average cost of $100.26 dollars per share at a total cost of $150 million dollars. In addition to share repurchases, Williams Sonoma also offers a quarterly cash dividend. In fiscal year 2022, total cash dividends sat at $216.3 million dollars, or $3.12 per common share. In 2021, dividends sat at $199.4 million dollars, or $2.60 per common share, with dividends sitting at $163.3 million dollars, or $2.02 per common share. In March, the Board of Directors authorized a 15% increase in the quarterly cash dividend, from $0.78 to $0.90 per share. As we can see, management’s capital allocation priorities are shareholder friendly. Aggressive share repurchases and increases in the quarterly cash dividend handsomely reward shareholders.
Management is also incentivized well, with a compensation structure that attracts and retains NEOs long term, increases shareholder value, and ultimately aligns management with shareholder interests. In 2022, the compensation program included a cash base salary, an annual bonus incentive, long-term incentives (paid out via performance-based RSUs and time-based RSUs), and stock ownership guidelines. The annual base salary, paid out in cash, is meant to retain NEOs in the short-term, ensuring high-quality, stable executive leadership. The annual bonus incentive is a bonus pool based on EPS performance based on a pre-set goal (which explains management’s extensive share repurchases), with the purpose of encouraging behaviors that support the company’s desired short-term goals and stable, long-term outcomes. The long-term incentives allow NEOs to build equity and ownership in the business and retain NEOs long-term. The long-term incentives are paid out based on a scorecard of relevant financial metrics that align with shareholder interests. These financial metrics include revenue (3-yr CAGR), EPS (3-yr CAGR), operating cash flow (3-yr average), and ROIC (3-yr average). Lastly, the stock ownership guidelines require NEOs to hold onto a certain percentage of shares they receive after taxes until they meet the ownership guideline, which states that every non-employee director must own at least $400,000 dollars worth of shares by the fifth anniversary of the director’s initial election to the Board of Directors. As we can see, management is incentivized very well, aligning management and shareholder interests. Specifically, the requirement for directors to build equity into the business retains long-term executive talent and ensures that management and shareholder interests are well aligned.
Williams Sonoma is a very efficient business. The business operates with a ROE of 74.2% and a ROIC of 48.2%. With a WACC of 10.3%, Williams Sonoma operates with a ROIC to WACC ratio of around 4.7x, showing the business’ ability to generate returns far higher than its cost of capital or hurdle rate. Looking further at efficiency metrics, we can see that Williams Sonoma has maintained a relatively high ROIC within the past 6 years (since 2017), with an average ROIC of 27.5% over that time period, showing that the business may hold a strong competitive advantage in the home furnishings and home goods sector.
Analyzing Williams Sonoma’s income statement, we can see some stellar sustained growth in revenue, gross profit, and earnings over the last decade. Since 2014, Williams Sonoma has grown its revenue at a CAGR of around 7.7%, with gross profit growing at a CAGR of 8.4% in that same time frame. The increased growth in gross profit in relation to revenue over that same time frame can largely be attributed to expanding gross margins. In 2014, Williams Sonoma operated with a gross margin of 38.8%, compared to today where the business operates at a LTM gross margin of 41.3%. As we can see, Williams Sonoma is a high margin business, showing that the business is able to efficiently convert revenue into cash. This is an especially important characteristic of the business as it operates at a high ROIC and ROIC to WACC ratio, meaning that it can reinvest these profits back into the business at high rates of return, rapidly compounding intrinsic value and handsomely rewarding shareholders. In terms of earnings, Williams Sonona has grown EBITDA at a CAGR of 11.5% since 2014, with EPS growing at a CAGR of 20.5% in that same time frame. The increased growth in EPS in relation to EBITDA over that same time frame can largely be attributed to share repurchases. Williams Sonoma is a cannibal, with shares outstanding decreasing nearly 32% since 2014.
Looking at Williams Sonoma’s balance sheet, we can see that the business is operating in good financial health. Williams Sonoma currently has around $297 million dollars worth of cash and equivalents on hand, with no long-term debt on the balance sheet. The business does have some debt on the balance sheet (net debt of $1.1 billion dollars), however, the business operates with no long-term debt and a healthy cash reserve on hand, showing management’s conservative financial approach and strong liquidity position.
Looking at Williams Sonoma’s cash flow statement, we can see some stellar sustained growth in net income and free cash flow, showing the business’ operational efficiency. Since 2014, Williams Sonoma has grown its net income at a CAGR of 15.6%, with free cash flow growing at a CAGR of 14.5% in that same time frame. This free cash flow growth rate since 2014 is slightly offset due to a 40% decrease in free cash flow from 2022 to 2023. The growth rate in free cash flow from 2014 to 2022 is 20.4%. This growth rate in free cash flow from 2014 to 2022 can largely be attributed to expanding free cash flow margins. In 2014, Williams Sonoma operated with a free cash flow margin of 5.9%, compared to today where the business is operating a LTM free cash flow margin of 10.3%. This increased free cash flow margin signifies the business’ increased ability to generate free cash flow from its revenue, which can then be used to repurchase shares, pay out a dividend, or reinvest cash back into the business at high rates of return.
After conducting a reverse discounted cash flow analysis, we can see that Williams Sonoma is trading at share prices that imply a -3% growth rate in free cash flow over the next 10 years, using a perpetuity growth rate of 3% (largely in line with US GDP growth) and a discount rate of 10%. With free cash flow growing at a CAGR of 14.5% since 2014 (or 20.4% from 2014 to 2022), it does seem that this growth rate in free cash flow implied by current share prices is very cheap. While free cash flows did fall 40% from 2022 to 2023, we still believe that this -3% growth rate is a steal for the quality business that you are buying. Factset places a 6% long term growth rate on the business (based on analyst estimates), showcasing the business’ growth potential in terms of revenue, profit, earnings, and free cash flow. Additionally, another positive catalyst for free cash flow growth is expanding free cash flow margins. As stated above, Williams Sonoma has expanded free cash flow margins from 5.9% of revenue in 2014 to a LTM free cash flow margin of 10.3% of revenue. If Williams Sonoma is able to continue to expand free cash flow margins, we believe that this current free cash flow growth rate implied by current share prices is extremely cheap.
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This article was originally published on Quiver Quantitative
